Canadian ETF investors seek currency hedging

Canadian ETF investors seek currency hedging

According to a recent Financial Post article, there is increasing demand among Canadian ETF investors for currency hedged products this year.

This was noted by Mark Noble, senior vice president and head of sales strategy at Horizons ETFs Management, who says the surge in demand came after the loonie’s big spring rally against the US dollar.

The loonie surged more than 15% from mid-January to late April against the greenback, which eroded returns for investors who were invested in unhedged products. This was a whiplash-inducing shock for those who had until then been enjoying big currency gains from direct exposure to US stocks – made possible by the Canadian’s steady decline against its US counterpart from 2012 to early 2016.

Most fund managers, including Horizons, recommend unhedged strategies for long-term investing because currency volatility evens out over time. But Noble said that retail investors tend to gravitate toward currency after being exposed to stocks and bonds. The massive US dollar rally in 2015 has inspired more investors to actively look at currency products.

The last few years stung for hedged investors, who experienced a loss of 0.73% from the S&P 500 last year – a loss that would have been made slightly worse by fees. Unhedged investors, on the other hand, enjoyed a return of nearly 20%.

Interest in currency hedging has surged as more Canadian investors grow to appreciate the rollercoaster dynamics of foreign exchange. Horizons ETFs saw that the money going into hedged ETFs this year is quadruple the amount going into unhedged ETFs.

The question now is how the balance between the loonie and the greenback will tilt going forward. Bloomberg analysts predict a marginal upward movement, from the current level of 75.9 US cents to 76.3 US cents.

Analysts at National Bank Financial, however, observe a lot of downward pressure for the loonie over the next 12 months, identifying the large current account deficit as the most major concern. Analysts at TD Economics also predict a slightly lower loonie, citing a widening differential between US and Canada interest rates.

Noble said that by hedging, Canadian investors should be able to factor currency moves into their portfolio. However, staying unhedged could also be beneficial as another avenue for diversification.

“If there’s any macroeconomic crisis, the U.S. dollar is going to go up,” Noble said. “In that kind of market, Canadian equities tend to decline. So if you have direct U.S. dollar exposure, you’re effectively diversifying your portfolio.”

I am only putting global and US assets for my clients into hedged products. If the CAD nears parity due to an minor to moderate oil shock (due to crisis in the middle east, tight oil driller defaults, war, etc) then I will switch back to unhedged. It's just too much to explain to clients that their underlying investments are making money but they are losing NAV because of the currency. They just see the top line figure: do I have more or less money. I can explain to them that they may eat a bit of upside return if the Canadian dollar falls in value, but I think it's fairly valued right now given the prices of oil and commodities.